DLTR's Q4 earnings were good, but not good enough

It’s been tough sledding of late for Dollar Tree, Inc. (NASDAQ:DLTR) stock. DLTR trades at the same levels it did two years ago, before its acquisition of competitor of Family Dollar. That deal was supposed to create a dominant player in the dollar stores industry, but it hasn’t quite worked out as planned. FDO same-store sales have weakened noticeably of late. And that’s not the only problem for Dollar Tree.

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Overall same-store sales have slowed, with FY15 (ended January 2016) comp growth of 2.1% the lowest in a decade.

New overtime rules from the Department of Labor, if passed, seem likely to increase labor costs and pressure margins. The same goes for state-level minimum wage hikes, four of which passed in November. A potential “border tax” adds another possible pain point for a company that imports a large percentage of its inventory.

Heading into today’s earnings report, DLTR stock had pressing near-term concerns as well: an “underperform” rating from Bernstein, its removal from Goldman Sachs “Conviction Buy” list and a 3.6% decline Tuesday in sympathy with ugly fourth-quarter results from Target Corporation (NYSE:TGT). So investors likely were just looking for some semblance of good news in DLTR’s Q4.

And “semblance” is about what they got. DLTR stock has retreated after opening up sharply, a move that makes some sense. Q4 was good enough to make investors feel a little better about Dollar Tree, but most of the questions surrounding the stock remain.

A Lower Bar for DLTR Stock

It says something about the “new” expectations for DLTR that the stock is up at all after the Q4 report. Same-store sales growth of 1.3% in Q4 was well below DLTR’s formerly standard 3%-plus figures. Full-year comps of 1.8% were 30 basis points lower than even last year’s disappointing figure.

In fact, early analysis pointed to the 0.2% same-store sales increase at Family Dollar as good news, since those comps were positive for the first time since Q1. Indeed, the fact that DLTR stock was up at all shows how much sentiment toward the stock has changed over the past two years.

This used to be a stock that grew same-store sales 3% to 5% a year, easily. The growth rate now is about half that. And Dollar Tree’s FY17 guidance doesn’t appear to imply much of a change, with the company expecting flat to low-single-digit same-store sales growth. EPS is guided to $4.20-$4.56 from $3.78 in FY16 — a 16% increase at the midpoint that would seem rather bullish for the stock. But I’m not sure that’s the case.

The True Concern for DLTR

The problem with the EPS guidance is that a chunk of the growth is coming from the fact that DLTR’s fiscal 2017 has a 53rd week. At the midpoint of guidance, about one-third of the guided growth would come from the extra week. Most of the rest is coming from synergies related to the Family Dollar acquisition.

Sales growth has decelerated to the point that DLTR isn’t going to be able to hold margins — particularly if labor pressure continues. Most retailers need 3% comp growth simply to leverage SG&A. Dollar Tree likely is looking at a third straight year of coming in below that figure.

Border tax concerns aren’t gone. Wage pressure isn’t easing, even if the Trump Administration reverses the overtime rules. The longer-term bear case here isn’t refuted by Q4. In fact, given the key sales figure and FY17 guidance, I’d argue that the long-term concerns remain just as valid going into the report as they are coming out.

Bottom Line on DLTR Stock

From here, DLTR looks like an “avoid.” The dollar stores space as a whole doesn’t look very strong at the moment: Dollar General Corp. (NYSE:DG) similarly has struggled of late. A forward P/E multiple of 18 for DLTR prices in some growth, but FY18 earnings will have a noticeable headwind from the loss of the 53rd week. Year-over-year earnings growth next year won’t be strong, at all, considering the end of Family Dollar-related synergies.

Even though DLTR is cheaper than it was, it’s hardly cheap excluding one-time benefits. Sales growth is decelerating, and margin concerns remain. Q4 results showed enough strength to keep the bears away. For now. But they hardly answered all, or even most, of the questions surrounding DLTR.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.